World Hurtling Towards Recession and Possible Financial Crisis
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The Budapest Business Journal’s corporate finance columnist Les Nemethy is worried by how sanguine the financial and corporate world appears to be about our economic prospects.
Over the past month, I have traveled within North America and Western Europe, met quite a few people, including senior bankers, and have been generally surprised by the feeling of “business as usual.” There is very little sense of impending doom or recession.
The reasons that are given for this include:
• The strength of the U.S. jobs market;
• The high aggregate savings and bank deposit levels of U.S. consumers;
• The U.S. Federal deficit has decreased to USD 1.1 trillion in May 2022, down from a peak of USD 4.3 tln in March 2021 (measured on a 12-month trailing basis).
Why do I believe this confidence is misplaced?
• The Michigan consumer confidence index is at its lowest since 1980.
• The distribution of those savings is skewed. 60% of Americans have little or none.
• Jobs reporting comes with a lag, and the number of unemployed is already starting to notch upwards.
• Q1 nominal growth in the United States was already -1.5%.
• The S&P is down 18.2% in the first 111 trading days of 2022, the fourth worth performance since 1932, diminishing consumer and investor confidence.
• Inflation continues to increase in most countries, raising the likelihood of further rate increases and the specter of further economic slowdown and decline in stock market indices.
• Bond yields are generally increasing rapidly worldwide (for example, in Germany, from negative a year ago to more than 1.5% on June 10), with yields on the EU periphery rising even faster (a year ago, 10-year Italian bonds yields were about 1% higher than German bonds, today they are more than 2% higher). The 10-year Italian bond yield had risen from 1% at the beginning of 2022 to 3.86% on June 1, despite massive bond-buying from the European Central Bank. While most believe the ECB will do “whatever it takes to save the euro” (as Mario Draghi famously said in 2012, turning the tide on the then euro crisis), the magnitude and speed of movement in Italian bond rates are a cause for worry.
While the U.S. Fed increases interest rates, the negative real interest rate of -7% means that monetary policy is still loose. The European Central bank is not even making noises about QT; it has limited scope to raise interest rates due to the effects this would produce on the periphery, and monetary policy is even looser:
After stating that inflation was not a threat, then calling it “transitory,” United States Secretary of the Treasury Janet Yellen admitted that she was wrong in her assessment of inflation (a welcome step) but went on to state: “I do not expect inflation to remain high, although I very much hope that it will be coming down now.” Since when is hope a strategy?
As explained in a previous article, I expect the Fed to tighten until something breaks (for example, a significant market crash or the credit markets freeze) and then begin its fifth Quantitative Easing (QE) program.
Will the Dollar Tank?
As the American financial commentator Peter Schiff stated: “The most important mistake investors [and I might add: central banks] are making is thinking that a recession will solve the inflation problem. In reality, it will make it worse. When the Fed pivots and launches QE5 to stimulate the economy, the dollar will tank, accelerating the increase in consumer prices.”
As macro strategist Lyn Alden recently stated, two major supply-side factors are redefining the world economy today.
1. For at least the past decade, there has been massive underinvestment in energy. Hydrocarbon drilling has plummeted. The Keystone pipeline was canceled. Uranium programs have been shuttered (by Germany, for example); no new uranium mining capacity has been developed since Fukushima. Meanwhile, an insufficient supply of the minerals required for alternative energy development (nickel, lithium, copper, etc.) constrains capacity.
2. For decades, the global value chain was optimized for efficiency. Since the Ukraine war, priorities have changed, and the focus suddenly became security of supply. Manufacturing closer to home, holding more inventory, and so on requires massive investment and contributes to considerable price increases.
Central banks have no control over the above factors. Nor do they have control of COVID and the Ukrainian war, which play further havoc with supply chains and price pressures. Whereas higher interest rates may dampen demand, so long as interest rates are negative in real terms, that will be insufficient to quell inflation, especially as long as the aforementioned pressures on supply chains remain with us or even intensify.
Of course, globally high debt levels (for government, corporations and individuals, giving a grand total of more than USD 350 tln) add to global economic fragility and lessens the ability to tolerate higher interest rates.
Les Nemethy is CEO of Euro-Phoenix Financial Advisers Ltd. (www.europhoenix.com), a Central European corporate finance firm. He is a former World Banker, author of Business Exit Planning (www.businessexitplanningbook.com), and a previous president of the American Chamber of Commerce in Hungary.
This article was first published in the Budapest Business Journal print issue of June 17, 2022.
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